Argentina, short-changed: Why the nation that followed the rules fell to pieces

By Joseph E. Stiglitz

It's a familiar refrain: Another Latin American republic, this time Argentina, can't get its acttogether. A profligate government and its populist policies have brought the country to ruin.Americans can smugly feel they are immune from such Latin ways.

Bewildered Latin Americans, however, see Argentina very differently. What happened, they ask,to this poster child of neo-liberalism and the notion that free markets would ensure prosperity?This was the country that did everything right. How could it have fallen so far?

There is some truth in both views, but ultimately, the one that's been popularized in America is, Ithink, misguided.

The crisis that had been brewing in Argentina for several years finally burst out last December.As the official unemployment rate approached 20 percent, with real joblessness substantiallyhigher, workers had had enough. Street demonstrations overturned a democratically electedgovernment. The country could not meet its debt payments. It had no choice but to default, andthe economic regime, with the Argentine peso fixed in value to the dollar, had to crumble. Sincethen, the economy has gone from bad to worse.

Argentina would be better off if there were less corruption in political life and if it had not rundeficits; after all, you can't have a debt crisis if you have no debt.

But the real question is, did those large deficits, corruption and public mismanagement cause theArgentine crisis? Many American economists suggest that the crisis would have been avertedhad Argentina followed the advice of the International Monetary Fund (IMF) religiously,especially by cutting back on expenditures (including at the provincial level) more ruthlessly.Many Latin Americans, however, think that the full IMF plan would have led to an even worsecrisis -- sooner. I think it is the Latins who are right.

Like most economists outside the IMF, I believe that in an economic downturn, cuttingexpenditures simply makes matters worse: tax revenues, employment and confidence in theeconomy also decline. Argentina is no more exempt from these basic economic principles thanwere the countries of East Asia in the late '90s. Yet the IMF said make cuts, and Argentinacomplied, trimming expenditures at the federal level (except interest) by 10 percent between1999 and 2001.

Not surprisingly, the cuts exacerbated the downturn; had they been as ruthless as the IMF hadwanted, the economic collapse would have been even faster. Social unrest would have comeearlier. And the calamity that followed the political unrest would almost surely have been everybit as bad. What is remarkable about Argentina is not that social and political turmoil eventuallybroke out, but that it took so long.

A closer look at its budget also shows how grossly unfair is the picture of Argentine profligacythat has been so widely painted. The official numbers reveal a deficit of less than 3 percent ofgross domestic product -- not an outrageous number. Recall that in 1992, when the United Stateswas experiencing a far milder recession than the current Argentine one, the U.S. federal deficitwas 4.9 percent of GDP. An economy in recession normally runs a deficit, as tax revenuesplummet and safety net expenditures increase; and there should be a deficit, for eliminating itsimply plunges the economy into a deeper recession.

But even that 3 percent figure is misleading, because of Argentina's decision to privatize itssocial security system in the 1990s, a move encouraged by the IMF. With that change, moneythat had been "inside the budget" moved "outside." In such cases, even if nothing happens to theeconomy other than the privatization, the apparent budgetary position greatly worsens becausethe pension plan surplus is taken off the books. Consider this: If we had had a privatized SocialSecurity system in 1992, for example, our deficit that year would have been more than 8 percentof GDP. Had Argentina not privatized, its 2001 budget would actually have shown a surplus. Thepension shift did not create a macroeconomic problem. Yet, the IMF saw things as worse.

Even putting this aside, at the centre of Argentina's budget deficits -- however one assesses them-- was not profligacy but an economic downturn, which led to falling tax revenues. Soaringinterest rates resulted not so much from what Argentina did but from the mismanaged globalfinancial crisis of 1997-98. All countries were badly affected, even Argentina, which the IMFstill considered to be an A-plus student in 1998.

If budget profligacy or corruption was not the problem, what was? To understand what happenedin Argentina, we need to look to the economic reforms that nearly all of Latin Americaundertook in the '80s. Countries emerging from years of poverty and dictatorship were told thatdemocracy and the markets would bring unprecedented prosperity. And in some countries, suchas Mexico, the rich few have benefited.

More broadly, though, economic performance has been dismal, with growth little more than halfof what it was in the 1950s, '60s and '70s. Disillusionment with "reform" -- neo-liberal style --has set in. Argentina's experience is being read: This is what happens to the A-plus student of theIMF. The disaster comes not from not listening to the IMF, but rather from listening.

That Argentina has moved to the bottom of the class has much to do with the exchange ratesystem. A decade ago, it had hyperinflation, which is always disastrous. Pegging the currency tothe dollar -- one peso equalled $1, no matter what the rate of inflation or the economic conditions-- acted, almost miraculously, to cure this problem. The IMF supported the policy. It stabilizedthe currency and was supposed to discipline to the government, which couldn't spend beyond itsmeans by printing money without breaking the peg. It could only spend beyond its means byborrowing. And to borrow, presumably, it would have to follow good economic policies. Amagic formula seemed to have been found to tame the seemingly incorrigible politicians.

There was only one problem: It was a system doomed to failure. Fixed exchange rates havenever worked. Even the United States couldn't live with a fixed exchange rate, going off the pegto gold in the midst of the Great Depression. Typically, failures do not appear overnight. They

are not usually the result of mistakes made by the country, but of shocks from beyond theirborders about which they can do little.

Had most of Argentina's trade been with the United States, pegging the peso to the dollar mighthave made sense. But much of Argentina's trade was with Europe and Brazil. The strong (mostwould say, overvalued) dollar has meant enormous American trade deficits. But with theArgentine peso pegged to the dollar, an overvalued dollar means an overvalued peso. And whilethe United States has been able to sustain trade deficits, Argentina could not. Whenever you havea massive trade deficit, you have to borrow from abroad to finance it. Although the United Statesis now the world's largest debtor country, outsiders are still willing to lend us money. They werewilling to lend to Argentina, too, when it had the IMF stamp of approval. But eventually theyrealized the risk.

The risks were brought home by the Mexican peso crisis seven years ago and more forcefully bythe global financial crisis of 1997-98 when, suddenly, the interest rates that Argentina paid to itsforeign and domestic creditors soared. Its level of debt seemed far less manageable, though evenas late as last December, when it went off the dollar peg, its debt-to-GDP ratio was only around55 percent. That's far less than that of Japan (where it is now around 130 percent) or manyEuropean countries, and even less than the United States not long ago (it was 64 percent in1992).

As the Asian financial crisis led to crises in Russia, and then Brazil, Argentina suffered more andmore. Interest rates soared and with the collapse of the Brazilian currency, Argentina simplycould not compete with its neighbour’s cheaper exports.

As if things were not bad enough, a falling euro made it harder for Argentina to export toEurope, and low prices for the commodities it sells further strained the economy. Moreover,while Europe and the United States preach free trade, they have kept their markets relativelyclosed to Argentina's agricultural goods.

The fixed exchange rate led to a vicious circle. As it became clear that a devaluation wasinevitable, lenders in pesos insisted on even higher interest rates to compensate them for thisexchange rate risk. The higher interest rates not only heightened the risk of devaluation, butcontributed to a new risk of default, which in turn led to even higher interest rates to compensatefor that risk.

Some say Argentina's fixed exchange rate system might have worked were it not for the bad luckof global financial crises. But that misses the point. International financial markets are highlyvolatile. The question wasn't whether the fixed exchange rate system would break, but only whenand how.

In the United States, when we have a downturn, everyone agrees that a fiscal stimulus is theremedy. Why is it, then, that the IMF believed that the opposite -- contractionary fiscal policies -- would succeed in getting Argentina out of its problems? The IMF does not release its economicmodels but it seems to have assumed that if Argentina reduced its deficit, foreign investorswould come in, bringing badly needed funds. But that premise is as silly as imagining that a

change in our government's deficit would lead investors to put more money into fibre optics,when there is already a vast over capacity.

Given the exchange rate, given the economic depression which the IMF policies had alreadybrought about, given the huge debt, given that the IMF did not provide any convincing economicstrategy to get out of the mess, given that there were open capital markets so that anyone whowanted to could move their investments to safer havens elsewhere in the world, it was highlyunlikely that anyone -- especially when the government signed an agreement to reduce its deficitfurther, predictably causing more unemployment and lower output -- would start investing more.

Argentina is a country rich in human and natural resources. Before the crisis, these resources,even with inefficiencies, generated one of the highest GDPs in Latin America. Those resourceshave not been destroyed by the financial crisis. What is required now is to "restart" the engine.Besides providing the assistance to do this, there is another way the United States can help: Onan "emergency" basis, we should open our markets to Argentine goods. More than anything else,it was trade with the United States that brought Mexico out of its crisis. This is a form ofassistance that would cost us nothing -- Americans, as consumers would be better off. At thevery least, we should stop demanding that the Argentines cut back even more, deepening theiralready severe depression and adding to the inevitable social problems.

Blaming the victim is not going to help matters.

Joseph Stiglitz, a professor of finance and economics at Columbia University, was awarded theNobel Prize in Economics in 2001. From 1997 to 2000, he was senior vice president and chiefeconomist at the World Bank.

http://www.washingtonpost.com/wp-dyn/articles/A3893-2002May10.htmlThe Washington Post Sunday, May 12, 2002